From as long ago as last year, President Emeritus of Harvard University, Larry Summers warned that a financial and economic storm is coming.

Later he prognosticated that inflation was not transitory and that it would linger and hurt the U.S. economy.

He was dismissed as all doom and gloom.

Now the United States (US) has an inflation rate of 8.6 per cent, the Dow Jones is down 18 per cent year to date, the housing market is contracting, gas prices are at US$5 a gallon, and the Federal Reserve has raised it rate by 75 basis points.

And there is also the ongoing war in Ukraine.

Summers, who was the Treasury Secretary during the Clinton administration and also served as Obama’s Chief Economic Advisor, made an appearance on Chuck Todd’s Meet the Press where he warned that a recession is coming.

“My best guess is recession is ahead and I base that on [the fact that] we haven’t had a situation like the present with inflation above four per cent and unemployment below four per cent without a recession following within a year or two. I think the likelihood, in order to do what is necessary to stop inflation, the Fed is going to raise interest rates enough that the economy will slip into recession.

“I think that view, which was not a common view a couple of months ago, is now the view of a number of statistical models and the view of a range of forecasters and I think it will increasingly become consensus view,” said Summers.

The Federal Reserve is aiming for an inflation rate at two per cent but is that too optimistic given the current economic landscape and no end in sight for the easing of supply chain disruptions?

“There are no historical precedents for inflation at the rate we have it, coming down to the rate the Fed has set at two per cent without a recession. I think all precedents point to a recession but then again there’s a first time for everything. I don’t want to make forecasts with certainty, but if you look at a whole range of indicators and what drives inflation (supply and demand), that tells me that by next year we will be seeing a recession in the American economy.”

Summers believes that cutting the tariffs is a good idea allowing for the hold down on prices and enabling the world’s largest economy to take a more strategic approach in dealing with China. This move, he says, could take a percentage point or more off the CPI over time.

Gas tax holiday is not the way to go

President Joe Biden is calling for the imposition of a temporary gas tax holiday and is hoping for bipartisan support. He has also rebuked the big oil companies for taking advantage of the situation and contributing to the pain Americans are feeling at the pump.

Larry Summer thinks the gas tax holiday is a bad idea On this subject he told Chuck Todd: “I’m no fan of a gas tax holiday. I think that’s kind of a gimmick and eventually you have to reverse it.”

Three moves the US government should make

Summers is suggesting that a bipartisan budget bill should be sought, one with three components.
The first would be a reduction in pharmaceutical prices (which would help healthcare and reduce the inflation rate).

Second, put in place the partial repeal of the Trump tax cuts which will take some demand out of the economy, increase confidence and reduce pressure on the Fed.

Third, put in place a more energy-supply approach that emphasises freeing up fossil fuels in the short run and making, with government support, the ultimate pivot to renewables.

Summers added: “All of that would take pressure off the Fed and bring down the inflation rate. It would also help to restore confidence.”

Many commentators and analysts are scolding the Chair of the Federal Reserve Jerome Powell and the Treasury Secretary Janet Yellin for not seeing the rising tide of inflation coming and moving sooner to quell it.

Having not acted sooner, will the Fed now over-react?

“The Fed has to find a balance. When the doctor prescribes antibiotics, if you stop taking them the moment you feel better, it can often be a mistake to not carry through. The worst thing we can do would be to start to stop inflation and not do enough to slay the dragon. The Fed has to be very, very careful.

“It has made huge mistakes being behind the curve. Its models, I don’t think are accurate for the latest situation and the latest forecast at the last meeting was wishful thinking in believing it could restrain inflation with unemployment simply rising slightly above four per cent,” said the former Treasury Secretary.